Ben Bernanke versus The World

With Greenspan sniping from the sidelines, history is watching to see if the Fed will flinch

by Darrell Delamaide

Thu 18 Nov 2010

Ben Bernanke must be more than a little jealous of Alan Greenspan. His predecessor as Federal Reserve chairman enjoyed 18 years of near-uninterrupted adulation as he presided over a monetary policy that resulted in the most crippling financial crisis in decades.

Even now, Greenspan’s oracular statements are accorded a certain reverence that is totally disproportionate to the true standing of the man who utters them. Showing minimal remorse and no shame for his own role in helping to create this mess, the former Fed chairman did not hesitate last week to criticise his successor for ‘pursuing a policy of currency weakening’ with the new round of quantitative easing.

Even before QE2 unleashed a global wave of criticism of the Fed, Bernanke rarely encountered the deference Greenspan received. When Bernanke goes to Capitol Hill to testify, he is greeted with suspicion and hostility bordering on rudeness.

The 84-year-old Greenspan should perhaps carry out less sniping from the sidelines – and start fully to enjoy his retirement – though that residual adulation, not to mention those consulting fees, are probably hard to resist. In any case, if he left the stage, that would remove only one of what appears to be an army of critics of Fed policy. Even conservative scourge Sarah Palin, who until now has not demonstrated the foggiest notion of economics, has joined the chorus of those condemning the Fed. The tide of invective has turned monetary policy into a partisan issue and created an incipient hysteria that the US central bank will be ‘politicised.’

The political and economic crisis is testing all of America’s institutions – and the Fed is no exception. Congress, the White House, the two-party system, the media – all are facing stiff challenges as a result both of the shorter-term effects of the financial upheavals and the longer-term results of a West-to-East shift in the world’s economic centre of gravity.

The role of a central bank in the national economy is, of course, a thoroughly legitimate subject for political debate. Two Republican lawmakers, Sen. Bob Corker of Tennessee and Rep. Mike Pence of Indiana, are sponsoring new legislation to strip the Fed of the employment leg of its dual mandate. This, the backers of the proposed change say, would allow it to focus exclusively on price stability – and stop sending confusing signals to the market.

Thus the Fed could become like the European Central Bank and the Bundesbank, with a laser-like focus on beating inflation. As Corker should know, however, it’s virtually impossible to get any legislation through the Senate right now and it’s hard to imagine a Democratic president signing that bill into law.

So, based with this torrent of complaint, what’s a central banker to do? Bernanke’s top lieutenants have embarked on an unusually high-profile campaign to counter the criticism. New York Fed president William Dudley, who is vice chairman of the Federal Open Market Committee, and Fed vice chairman Janet Yellen both gave on-message interviews attempting to allay concerns about the dollar and inflation.So far, so good. The worst thing the Fed could do now is to flinch. With a new round of euro panic in the offing, the world can’t afford to have the two biggest central banks wavering at the same time. Ireland is being pushed in the same direction as Greece was a few months ago. The motto of the people at the ECB who are encouraging Ireland to go down the Greek road seems to be: ‘‘if you think you don't need a bailout now, we'll keep making comments that will encourage the financial markets to pound your bonds until you do.’

The problem with Bernanke propagating the courage of his convictions is, however, that he has been so wrong in the past. Most notoriously, he said in 2007 that the sub-prime mortgage crisis could be contained. This creates a credibility problem – but it doesn’t mean Bernanke is wrong about QE2.How wrong could he be, really? In the absence of any sign of inflation, the worst that can be said about QE2 is that it’s futile. Bernanke and everyone else knows that fiscal policy is the best way to address the US growth problem, but the Fed is not responsible for fiscal policy and now the hostile reaction to QE2 means no one is very receptive to its advice on that subject.

The scathing criticism from all sides was cited as the reason that Treasury yields actually went up earlier this week. Ditto for the dollar, at least versus the euro. It could be simply a question of buy on rumour, sell on news. After all, interest rates and the dollar have drifted downwards since the Fed first started talking about QE2 last summer. Or perhaps it is the beginning of a new rumour – that the Fed will scrap QE2.

So welcome to history. Future chroniclers of early 2000s monetary affairs will allocate credit and blame for the crisis and its aftermath to Greenspan, Bernanke and the rest. In future historical accounts of the crisis and the aftermath, it could be that QE2 will scarcely merit even a footnote. What counts – now, and for the historians - is whether the Fed displays enough steely resolve to maintain its independence. Bernanke’s task is not only to show that resolve but also to prove that he deserves the mantle of independence that his fiercest critics have now cast into doubt.

Darrell Delamaide is a member of the OMFIF Board of Contributing Editors.